So the initial "insert" part works, but the end "Format Manuscript" part fails?
I expect the problem is due to the fact that FoldingText isn't using the standard text system. It getting all of its input through a hidden HTML text field, so the "body" of the text isn't really visible to the system as it is in most apps.
Possible workaround, what happens if you select all text, and then run the "Format Manuscript" command? FoldingText makes select text accessible for OS X services and things like that.